Commodities are governed by supply and demand - more than any other variable. Just take a look at the precious metals bull market we’ve enjoyed since 2001.

Right now some metals are poised to reach new all-time highs because of production deficits (aka lack of supply), while other metals still remain hostage to an onslaught of new supplies - so their prices are dropping.

Silver falls in that “too much supply” camp. More than any other precious metal this year, silver’s prices will be put to the test. We’re all waiting to see if silver’s price can hold up under the growing bombardment of new production.

Over the last five years, silver prices have surged more than 250% to just under US$17 an ounce at the moment. On May 20th, my Commodity Trend Alert (CTA) service, turned “neutral” on silver, after my CTA subscribers earned big profits on several existing open silver positions since 2003.

But the tides have turned. And now rising supplies are forecasting a sizable silver correction.

Meanwhile, gold is still soaring. Gold production peaked in 2001 and continues to decline this year, which is VERY bullish for gold prices. But that’s certainly not the case for silver and to a lesser extent, palladium.

Could Silver Break Away from Gold?

Gold and silver generally track each other in a bull or bear market. When gold goes up, silver goes up and vice versa. But in this case, a divergence might be possible, if only temporarily.

In the base metals arena, a similar price divergence has already happened after seven years of generally spectacular gains for the complex. These include namely copper, lead, tin, nickel, iron-ore (steel), aluminum and zinc. Over the last 18 months, nickel and zinc prices have crashed while tin, lead and copper prices have posted gains. It’s not impossible for metals to break away from the primary uptrend if supplies begin to saturate individual fundamentals.

Over the last 12 months, gold prices have risen 37% while silver has gained 31%. Both metals continue to track each other on a total return basis.

But thus far in 2008, gold prices have risen just 8% while silver has rallied 15%. The fundamentals, however, don’t support silver’s higher returns this year.

Will Investor Demand Support Silver?

Gold is rapidly approaching its first year of net supply deficit while silver is increasingly becoming a net surplus commodity. And according to textbook economics, rising supplies eventually dilute a rising price trend and drag prices back down.

Considering the demand for both silver jewelry and silver industrial supplies is waning, the bulk of global demand for silver will have to come from investors going forward. This will come mainly from exchange traded funds like SLV or the iShares Silver Trust in the United States and other silver ETFs traded in London and Zurich.

I have serious doubts investor demand will continue to support silver at these levels without suffering a major correction first.

The iShares Silver Trust has already seen a massive increase of silver accumulation since 2006 - over 180 million ounces. Silver supply has surged since 2001, according to GFMS, a precious metals consultancy firm, rising to 670.6 million ounces. Unless investor demand consumes this rising supply - and more is projected in 2008, then prices will decline. That’s because industrial demand has probably peaked.

Last year, industrial demand for silver increased 7.2% to a record 455.3 million ounces, according to the 2008 World Silver Survey. That offset the long-term decline in demand for traditional usage, mainly in photography, jewelry and silverware.

But another survey by Barclays Capital points to alarm bells for the silver market. The survey shows new supplies just hit the market this year. Barclays believes mine production will grow by 6.5% in 2008 and faster than last year’s increase of 3.6%. That could create possibly the largest surplus of silver in over 20 years.

A disappointing initial public offering (IPO) in London is another bearish signal for silver bulls.

Mexican silver company, Fresnillo PLC, went public in London earlier this month and declined 7.5% on its debut - that’s a bad sign. Despite stronger silver prices this year, the IPO was not received well in the markets.

Gold and Platinum: Precious Metal Kings

Though I’m not predicting a long-term silver decline, I think it’s time to reduce your exposure during current price strength. The big picture for sister metals, gold and platinum, however, remains incredibly bullish because supplies continue to tighten.

Pages: 1 2

Pages: 1 2